Daily Tax Update - June 11, 2010

IRS AND TREASURY ISSUE TWO NOTICES REQUESTING COMMENTS AND PROVIDING GUIDANCE ON SECTION 382 REGULATIONS: Today, the IRS and Treasury issued two notices addressing the regulations under section 382 regarding the limitation on use of net operating loss carryforwards and certain built-in losses following an ownership change.

  • Notice 2010-49 requests comments relating to possible modifications to the treatment of shareholders who are not 5-percent shareholders (“Small Shareholders”) for purposes of determining whether there is an ownership change.
  • Under section 382, there is generally an ownership change if the ownership of one or more 5-percent shareholders has increased by more than 50 percentage points. Under section 382(g)(4)(A), Small Shareholders are aggregated and treated as one 5-percent shareholder for purposes of applying this rule. This rule is modified, however, by section 382(g)(4)(B) and section 382(g)(4)(C). Section 382(g)(4)(B) provides that the aggregation rule must be applied separately to Small Shareholders of parties to certain reorganizations and section 382(g)(4)(C) provides that, except as provided in regulations, similar segregation rules apply in determining whether there has been an owner shift involving a 5-percent shareholder and whether such shift results in an ownership change.
  • The notice describes two general possible approaches to the treatment of Small Shareholders that may be incorporated into modified regulations: (i) the Ownership Tracking Approach and (ii) the Purposive Approach. The Ownership Tracking Approach tracks all changes in ownership without regard to the particular circumstances. Under this approach, any transaction that allows the corporation to track the increase in ownership interests held by Small Shareholders results in the segregation of Small Shareholders into a new public group, which is treated as a single 5-percent shareholder. Under the Purposive Approach, the rules would seek to identify more specifically the circumstances in which abuses are likely to arise. The current regulations primarily reflect the Ownership Tracking approach. The notice requests comments concerning whether the regulations should follow the Ownership Tracking Approach, the Purposive Approach, or another approach.
  • Notice 2010-50 provides guidance regarding the effect of fluctuations in the value of one class of stock relative to another class of stock for purposes of measuring owner shifts of loss corporations that have more than one class of stock outstanding.
  • Section 382(l)(3)(C) provides that, except as provided in regulations, any change in proportionate ownership of the stock of a loss corporation attributable solely to fluctuations in the relative fair market values of different classes of stock shall not be taken into account. The current regulations under section 382 do not provide any specific guidance on section 382(l)(3)(C). The notice states that the IRS and Treasury are aware that taxpayers employ a number of differing methodologies to interpret and apply section 382(l)(3)(C), including the Full Value Methodology and the Hold Constant Principle
  • Under the Full Value Methodology, the determination of the percentage of stock owned by any person is made on the basis of the basis of the relative fair market value of the stock owned by such person compared to the total fair market value of the outstanding stock of the corporation. Thus, changes in percentage ownership as a result of fluctuations in value are taken into account if a testing date occurs, regardless of whether a particular shareholder actively participates or is otherwise party to the transaction that causes the testing date to occur; essentially all shares are “marked to market” on each testing date.
  • Under the Hold Constant Principle, the value of a share, relative to the value of all other stock of the corporation, is established on the date that share is acquired by a particular shareholder. On subsequent testing dates, the percentage interest represented by that share (the “tested share”) is then determined by factoring out fluctuations in the relative values of the loss corporation’s share classes that have occurred since the acquisition date of the tested share. There are generally two alternative methodologies for implementing the Hold Constant Principle. Under the first methodology, the hold constant percentage represented by a tested share is recalculated to factor out changes in its relative value since the share’s acquisition date. Under the second methodology, the percentage interest represented by a tested share is tracked from the date of acquisition forward, adjusting for subsequent dispositions and for the subsequent issuance or redemption of other stock.
  • The notice states that because of the complexity of the issues involved that the IRS will not challenge any reasonable application of either the Full Value Methodology or the Hold Constant Principle, provided that a single methodology is applied consistently. The notice states that either of the two alternative methodologies for implementing the Hold Constant Principle are reasonable applications of that principle.
  • The notice states that taxpayers may rely on the guidance in the notice until the IRS and Treasury issue additional guidance regarding fluctuation in value under section 382(l)(3)(C). In addition, the notice requests comments on what it describes as the “threshold” question of whether interpreting the fluctuation in value rule in section 382(l)(3)(C) broadly to require rules for factoring out fluctuations in value, such as may be done through the methodologies that employ the Hold Constant Principle, is appropriate in light of the purposes of section 382.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com.

H.R.5518: To amend the Internal Revenue Code of 1986 to allow the energy investment tax credit and the credit for residential energy efficient property with respect to natural gas heat pumps.
Sponsor: Rep Titus, Dina [NV-3] (introduced 6/10/2010) Cosponsors (4)

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